Don't Take Their Word for It: The Misclassification of Bond Mutual Funds

We provide evidence that bond fund managers misclassify their holdings, and that these misclassifications have a real and significant impact on investor capital flows. The problem is widespread, resulting in up to 31.4% of funds being misclassified with safer profiles, compared to their true, publicly reported holdings. Misclassified funds-those that hold risky bonds but claim to hold safer bonds-appear to on-average outperform lower risk funds in their peer groups. Within category groups, misclassified funds receive more Morningstar stars and higher investor flows. However, when we correctly classify them based on actual risk, these funds are mediocre performers.

Automated summary

The study shows that many bond fund managers misclassify their holdings, leading to significant impact on investor capital flows. While the misclassified funds may appear to outperform, they are actually mediocre performers when correctly classified based on actual risk.